Euro Area – PMI/Markit Surveys do not provide the key to a possible job recovery in the short term

The PMI/Markit synthetic index for the Manufacturing Sector was in March lower than in February. It was at 46.8 versus 47.9 a month before. This means that activity in the manufacturing sector is shrinking more rapidly in March as the index was below 50.

On a larger time scale for the first quarter of 2013 activity is on average below 50, so it is decreasing but at a slower pace than during the last three months of 2012 (47.5 in Q1 2013 versus 45.9 in Q4 2012)

But the improvement seen at the beginning of the year was probably temporary.

At first glance, countries’ indices in the Euro Area are weaker as all of them are now below 50. Every country is shrinking. Ireland which was above this threshold since March 2012 is below it in March. In Germany the index was above 50 in February but below in March. In the short run, these two countries are faltering and cannot be the engine for Euro Area expansion.

In Italy and Spain the beginning of the year improvement is now over and their indices converge to French index level which is still low.

Details of this survey show that New Orders dynamic is also weaker. Every country index is now below 50. Demand is not strong enough to be able to converge to a stronger growth trajectory. Then why is austerity policy the rule rather than the exception? Austerity implies lower demand as it reduces government expenditures or increases private sector taxes that weigh on private sector behavior

The New Orders to Inventories ratio is interesting as its profile is consistent with 3 month change of the Industrial Production Index. The chart is clear on that point. The ratio’s improvement at the beginning of 2013 is over. Inventories are again high enough to satisfy demand. It will not be needed to produce more. This means that industrial production will remain weak in the coming months and the manufacturing sector will not be the source of a renewed dynamic.

In the short run, exports will not help. The New Export Orders are all below 50 except Netherlands. And impulse cannot be expected for the external sector in the coming months.

This means that the economic outlook is still very fragile for the Euro Area. The idea of a rebound during the second part of this year has to be questioned. The best way for an improvement would come from an extra euro Area impetus. But even in this configuration a global improvement cannot be expected for this year as usually Germany takes a large part of the export change. France, Italy and Spain take then what Germany cannot do. This sequence means that it can be hard to imagine a global improvement from next summer on.

If the external side cannot play this role, then change has to come from inside. But how can an improvement in internal demand be expected? Can a strong investment dynamic be expected in the coming months? What could be the catalysts of such a new behavior? Surveys seen above do not go in this direction. Can higher households’ expenditures be expected? Hard to imagine as purchasing power is decreasing and employment is lower quarter after quarter.

In the past, impulse came from outside Euro Area. At the beginning of the 80’s European growth has benefited from Reagan economic policy and then from the counter oil shock (oil price dropped deeply). At the end of the 90’s the new technology shock helped a lot and at the beginning of the 2000’s China was a catalyst. We cannot expect rapidly this kind of external improvement. This means that if Europe has to make structural reforms it will be done in a weak growth environment. This is then always more complicated as noone has degree of freedom to adjust its behavior. That’s why a change in policy is needed. To help the recovery, budget balance target has to be postponed later in the future. At the same time the ECB has to be more active.

In a monetary and fiscal game, these two policies have to be in opposition when the economy is close to its long term equilibrium. If it is not the case, if the gap to GDP growth trend is large then both policies have to be on the same side. (Read Alan Blinder paper on this point http://bit.ly/YRdbDv after page 22)

With wrong policy coordination the risk is to stay far from the growth trend. This could then lead to an increase of unemployment as economic activity is too low. In February unemployment rate was 12% as it is shown on the chart below. It is its highest level since 1995. If as I expect GDP change will be negative in 2013 then unemployment will increase rapidly and could be a source of social instability.

On the chart below, and except in Germany we see that the labor market dynamic is weak everywhere. In Italy and France unemployment rate is getting higher rapidly. It’s the same in the Netherlands even if the level is lower. With that in mind growth is really the main target to attain and the recipe to reduce the risk of social unrest.